Loans 108-04090070

There are 2 types of loan/debt forgiveness.

The first is when:

• a person is owed funds from an entity
• an entity is owed funds from another entity
• the loan or debt appears as a liability on the entity's balance sheet
• the loan/debt is forgiven. It is known as a commercial debt forgiveness and capital gains may apply

The second is when:

• a person owes funds to an entity
• an entity owes funds to another entity
• the loan or debt appears as an asset on the entity's balance sheet
• the loan/debt is forgiven. The loan amount may be treated as a dividend under Division 7A of the Income Tax Assessment Act 1997

The CAO must establish:

• if the loan forgiveness is for a loan to/from an entity
• when the loan amount to the entity is forgiven, if it is considered:
• a one off event
• not part of the usual income, and
• excluded from assessment of the entity's income

The CAO must determine:

• if deprivation applies when the loan is forgiven
• which supporting documents are required to show the loan amount has been forgiven.
  Note: loan forgiveness declared on an entity's financial statements for a previous financial year is not enough evidence that the loan has been forgiven

A loan forgiveness that occurred in a previous financial year is only accepted if:

• the loan amount has been declared on the tax return, or
• under tax legislation, it is not required to be declared

If the loan amount should have been declared on the tax return, but has not been, the loan forgiveness is not accepted. Continue to assess it as a loan.

• A Deed of Debt Forgiveness is required only when a loan amount has been forgiven in a current financial year
• The entity's minutes are also required to establish the date the decision was made to forgive the loan amount
• If the loan forgiveness has been backdated, the date of event for the loan forgiveness is the date the decision was made. Loan forgiveness cannot be backdated prior to the date of the decision
• The amount forgiven must be shown on the entity's financial statements
• A balance sheet is required as at the date of:
• the loan forgiveness, or
• a later date. For example, the date of a new claim that shows the loan forgiveness

In the past, private trusts and companies received a TNA This is now changed as entities have moved to self-assessments.

When a company lodges a tax return it does not receive a TNA. If it is:

• required to pay tax, it receives a Statement of Account
• lodging an amended return, it only receives an amended Statement of Account if the tax amount payable changes

When a trust lodges a tax return, and it has a:

• net loss, it does not receive a TNA
• net profit, which is not distributed to the beneficiaries, it receives a TNA
• net profit which is distributed to certain beneficiaries, then a TNA is issued for the beneficiaries if they are:
• a minor
• a foreign resident
• a person who has been legally declared as disabled
  For example, a trust makes a distribution to a minor and a TNA is issued to the minor based on the amount received. If there are multiple minors, a TNA is issued for each minor

When a trust lodges an amended tax return, a TNA is only issued in the above cases.

Trusts and companies have 4 years from the date the tax return was assessed by the ATO to lodge an amended return.

The time frame is 2 years if the trust or company is a:

• small business entity
• partner in a partnership, or
• beneficiary of another trust

A small business entity has an annual turnover (gross income) is no more than $10 million. Prior to 2017, the annual turnover could not exceed $2 million.

The trust or company must lodge an objection with the ATO if they wish to lodge an amended tax return outside the appropriate time frame.

To confirm an amended tax return has been lodged with the ATO, the following evidence is required:

• for companies, the amended Statement of Account
• for trusts, an amended TNA
• where there is no amended Statement of Account or TNA, a copy of the ATO tax portal lodgement which shows the date lodged and the applicable financial year
• a letter from the ATO

A commercial debt is when part/all of the interest payable on the debt is, or would be, an allowable deduction.

There may be capital gains implications when a loan is forgiven.

Under the commercial debt forgiveness rules, a loan forgiveness amount may be reduced in the following order:

• prior year losses
• prior year net capital gain losses
• deductible expenses. For example, the net income is a $5000 loss and the loan forgiveness amount is $1000, then the net income is a $4,000 loss

If all the above amounts are reduced to nil, any remaining net forgiven amount is disregarded.

Loan forgiveness can be displayed differently on each tax return. For example, the tax return may show the loan forgiveness amount as:

• income
• a debt forgiveness amount
• a reduction in 1 or more of the above methods, or
• an amount on the capital gains schedule

The CAO must ensure the tax return displays one of the above methods. For example, if the loan forgiveness was reduced by any prior year losses, the balance of the prior year losses should be reduced by the forgiven amount of the loan.

If the tax return does not show the loan forgiveness, the CAO must:

• contact the customer or accountant to discuss the loan forgiveness. If the accountant advises the amount forgiven did not need to be notified on the tax return, request a letter from them with:
• the reasons why it was not notified
• the relevant tax legislation
• forward the letter to the Income and Asset Helpdesk for determination

• Capital gains do not apply if the loan was forgiven:
• as a result of action under bankruptcy law
• in a deceased person's will
• for reasons of natural love and affection (this is rare for a company or trust)
• The debt is waived and the waiver constitutes a fringe benefit
• The amount of the debt has been, or will be, included in the assessable income of any income year
• The debt is a tax related liability

The purpose of Division 7A is to prevent profits or assets being provided tax free to shareholders or their associates, for example, a relative of the shareholder.

A payment or other benefit provided by a company to a shareholder, or their associate, can be treated as a dividend for income tax purposes even if the company treats it as something different, such as a loan, advance, gift or debt write-off.

This also applies when:

• a company provides a payment or benefit through another entity to a shareholder, or their associate
• a trustee forgives a debt owed by a company shareholder, or their associate, during the year
• a trustee makes a payment or loan to a shareholder or their associate during the year, either directly or through one or more connected entities

The loan appears as an asset on the balance sheet of the entity when the loan amount forgiven is declared as a Division 7A, unfranked dividend on the tax return of the individual, trust or company, that owes the funds to the entity.

The loan does not appear as an asset if it is a complying loan for ATO purposes.

The 2 types of complying loans are secured and unsecured loans.

• To be a complying loan all of the following must apply:a secured loan has 25 years to be repaid and an unsecured loan has 7 years to be repaid
• The person or entity makes minimum yearly repayments
• The person or entity has been paying adequate interest on the loan each year. (Adequate interest for 2020/21 financial year was 4.52%)

If all of the above conditions are not met, then the amount forgiven may need to be declared as an unfranked dividend on the tax return for the person or entity that owes the funds.
For example,

• AAA Pty Ltd loaned $50,000 to BBB Pty Ltd
• $50,000 appears as an asset on the balance sheet for AAA Pty Ltd
• the tax return for AAA Pty Ltd shows interest income received for this loan
• the balance sheet also shows the loan balance has been reducing from the original $50,000
• the amount forgiven is a complying loan and an unfranked dividend is not declared on the tax return of BBB Pty Ltd

If no interest has been declared, or the loan balance has not been reduced, then unfranked dividends may need to be shown on the tax return of the individual, trust or company that owes the funds.

If an unfranked dividend is not shown on the relevant tax return:

• request a letter from their accountant stating:
• the reason why, and
• the relevant tax legislation
• forward the letter to the Income and Asset Helpdesk for determination

Division 7A does not apply to amounts already assessed as income, such as normal dividends or director's fees.

A loan is also not treated as a dividend if:

• it is made to another company which is not acting in the capacity of trustee
• the payment would be excluded from the shareholder or associated assessable income under a provision of the tax law
• the yearly minimum repayments are not paid with interest
• it is an amalgamated loan in the year it was made and the minimum repayments are made in the following year
• it is a distribution made when a liquidator is winding up a company

For more information, check the ATO website.